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Simple Climate Tax Scheme

On 07 Apr 26 an Oil Drum blogger named Squalish (http://www.theoildrum.com/node/2499) wrote a response to a debate about government's role in climate change policy. In that piece Squalish described an idea whereby all CO2 taxes would be pooled into a separate fund and "rebated annually in an equal amount to every US taxpayer".

This got me thinking. What a clever idea but why not bypass the government coffers entirely?

Here is how a simple scheme might work as illustrated by the story of Joe Average and Jane Median.

Joe and Jane live in different jusidictions. Both use 1000 litres (250 US gal) of gasoline per year, which coincidentally happens to be the average for all drivers in their areas. Both Joe and Jane pay $1 per litre ($4 US gal) for gasoline at the pump which amounts to $1000 per year each for fuel.

Joe and Jane's governments see a need to reduce fossil fuel consumption to help combat climate change. As such each government will enact legislation to put a price on carbon.

Joe Average lives in a jurisdiction where the government introduces a revenue neutral carbon tax of $1 per litre, with vague promises to offset his pain at the pump with equivalent income tax reductions.

Jane Median lives in a jurisdiction where the government has also introduced a carbon levy of $1 litre. However, Jane's government has appointed an arm's-length non profit agency to collect all this levy. This agency's sole mandate is divide and refund the total amount evenly amongst all registered drivers of which Jane is one.

Once the legislation is enacted both Joe and Jane are now paying $2000 per year for their motor fuel. Neither is happy about it. Nonetheless, unhappiness is a powerful (albeit negative) motivator to make the desired changes: to use less fossil fuel.

Meanwhile Joe is still waiting for his government to enact legislation to lower his income tax by $1000 per year. He is in a higher income tax bracket so he doesn't hold out much hope that he'll see that deep a cut. Jane, on the other hand, is already receiving her refund cheque for $83 each month, which almost totally offsets her carbon levy ($83x12=$996). Jane's cash reward is a powerful positive motivator. Jane is certainly in the better frame of mind than Joe.

Now both Joe and Jane are environmentally savy consumers and they embark on a conservation campaign which saves them 10% on their annual fuel usage. ie. each drops to 900 litres (225 US gal) per year. Let us suppose that Joe and Jane are ahead of the curve and the average driver in their respective jurisdictions are content for the time being to continue consuming 1000 litres (250 US gal) per year.

As a result of their conservation efforts both Joe and Jane are rewarded by an annual savings of $200 each at the pump. However, each is still paying $1800 per year at the pump, substantially more than before the carbon tax. Joe is the least happy. He is still spending $800 MORE for fuel than before his enlightened government introduced the carbon tax. Jane meanwhile still experiences the pain when she fills up at the pump. However, she is still receiving her $83 refund cheque each month. So her net outlay is now $800 per year or $200 LESS than she was spending before her enlightened government introduced the carbon levy. Jane feels like the program is paying her to conserve.

Both governments are of the view that to be effective, the price of carbon needs to be escalated in a predictable and scheduled manner going forward. In both cases the next scheduled increase brings the carbon tax/levy to $2 per litre. Both Joe and Jane are now going to be paying $2700 per year for fuel. They are good conservers but they are finding it difficult to conserve more than the original 10%. Fortunately, now that fuel is $3 per litre ($12 per US gal) lots of non fossil alternative fuels are price competitive. Joe and Jane switch vehicles to take advantage of an alternate fuel which is priced at $2.50 per litre ($10 per US gal).

Joe saves $450 per year by switching to an alternative fuel. However, he is still paying $1250 more per year than before the carbon tax as introduced. He is still waiting for his income tax offset to kick in.

Jane on the other hand is still ahead of the curve amongst her fellow drivers. She also saves the same $450 per year at the pump by switching to a cheaper alternative fuel. However she now receives $166 per month in refund cheques from the carbon levy fund. Her net outlay has dropped to an amazing $250 per year or $750 less than before the carbon levy was introduced !!! What is even more amazing is that Jane's alternative fuel producer is receiving the full $2.50 outlay at the pump. In fact Jane's government is able to collect a fair tax on that $2.50 alternate fuel as well. No need for profit or tax holidays to stimulate the acceptance of the alternative fuel.

The question is which of Joe or Jane would be more likely:

to tell a friend about their fuel conservation/alternative fuel strategy

to live in a jurisdiction which sees total fossil fuel usage drop

to vote for their government next time round

At the end of the day the purpose of any carbon pricing scheme is to reduce fossil fuel consumption. The success of any program hinges on a buy in from the consumer. The consumer has to do the conserving or switching. There are a number of reasons why this simple scheme would have a better buy in than alternatives.

There is a widespread mistrust of governments and government programs. Jane's government is acting as the enabler and not the doer. The fact that this scheme is administered at arms length should lead to better public acceptance. Better public acceptance should translate into better results.

The collect, average and refund math naturally rewards consumers who position themselves below the average and penalizes those which are above the average. Those consumers at the average are revenue neutral. This scheme will be perceived as fair. Schemes which are perceived to be fair have a better acceptance.

The only way to game the system is for the consumer to reduce their fossil fuel consumption below the average. That way they'll get a bigger refund cheque than they spent in the carbon levy. This motivates the consumer to do exactly what the program set out to accomplish: to reduce fossil fuel consumption or encourage a switch to non carbon fuel sources.

Furthermore as more consumers try to conserve their way to below the average that average itself will drop. This naturally nudges the consumer to redouble efforts to continue fossil fuel conservation or replacement. This can be further amplified if the carbon levy is itself escalating in time.

The monthly refund cheque will be viewed in a positive light. When a taxpayer overpays income tax and receives a refund cheque upon filing, they don't typically think of it as the government giving them back their money but simply as the government giving them money. This extra positive reinforcement should amplify the effectiveness of the program.

Alternate non fossil fuels are naturally rewarded in the scheme. First of all the price of fossil fuel is raised to help new competitors enter the picture. If the consumer were to switch to biofuel, electric or hydrogen vehicles they would still receive the rebate cheque to offset that higher alternate fuel cost. The fossil users subsidize the non fossil users. This should accelerate the uptake of alternative fuel sources. This should help naturally sort out the alternative fuel sources which scale well from those which don't.

This scheme has a natural end point. Once all the consumers have conserved to zero or converted to non fossil fuel sources there would be no carbon levy collected and no refund administered. The program will have achieved its objectives and could be disbanded without any impact on government revenues. There is no incentive to run this program beyond its natural end point.

Left on its own price induced rationing can be very unfair. Unfairness on this global scale can lead to many undesirable consequences which are worth avoiding. The pricing scheme that Jane's government adopted attempts to address this fairness issue by naturally rewarding those who do the right thing while at the same time penalizing those who choose not to. The beauty of this scheme is that this reward and penality occurs regardless of your ability to pay. This is not to say that Jane's government would find it easy to implement such a scheme. Jane's government would have to address two vunerable areas:

registry fraud

cross jurisdiction shopping

There are technical solutions to registry fraud (eg. biometric smart card, encription) but the political will and cost to implement them may be a problem. The cross jurisdiction shopping is a problem common to any carbon pricing scheme. Unless neighboring jurisdictions implement similar programs, consumers will purchase fuel in the lower cost jurisdiction if possible.

Some jurisdictions have examples of a government enabled arms length organizations created for the purpose of collecting and redistributing funds: eg. the state run lotteries. However, the US currently consumes 1.55 billion litres of gasoline per day (388 million US gal). At a $1 per litre levy Jane's non profit would be handling close to $1.6 billion/day. This flow of money is orders of magnitude larger than lottery proceeds. This is a non trivial float of money and by definition will difficult to administer cleanly.

The world is facing two fossil fuel challenges going forward: carbon dioxide induced climate change and Peak Oil. Fortunately, the solution to both is the same: consume less fossil fuel. The two crisis are different, however. In the climate case, if we fail to act fossil fuel rationing will not be a natural consequence. In the Peak Oil case, if we fail to act we'll get fossil fuel rationing regardless. The way to mitigate the climate crisis dictates that we collectively organize to artificially ration fossil fuel. Peak Oil on the other hand dictates that we collectively organize to smoothly ration a geologically declining supply of a fossil fuel (oil).

The price we pay for fossil fuel is a powerful lever in determining how much we consume. It follows that intervening in the market to put an artificial price on the carbon in a fossil fuel will induce us to consume less. This is at the heart of most climate proposals (including that employed by Jane's government). In theory putting a price on carbon would ration fossil fuels and we'd simultaneously address the needs of climate change and Peak Oil. However, as with all artificial market interventions the devil is in the details.

There are no perfect solutions here. As the old joke about thermodynamics states: you must play the game, you can't win, you can't break even and you can't even quit the game.

Doing nothing about these challenges is a choice. I believe that Jane's government offers us a better choice.